Twice in the last three years, the IRS has offered taxpayers with undisclosed foreign assets an opportunity to voluntarily disclose the unreported assets, pay back taxes and penalties, and avoid more severe penalties and criminal prosecution. These voluntary disclosure opportunities were well-timed with the success achieved by the U.S. Department of Justice (DOJ) and the IRS in obtaining once-“secret” Swiss banking details from UBS, and criminal prosecutions of US taxpayers who did not report and pay tax on foreign income.

The two disclosure programs together resulted in some 30,000 taxpayers coming forward and reporting offshore assets at numerous financial institutions in multiple foreign countries around the world. The programs also yielded a vast database of information for US law enforcement agencies about offshore banking, the financial institutions and people, like bankers, trustees and lawyers, who facilitated non-compliant offshore banking. Armed with this information, the US has looked beyond UBS and Swiss banks and is now investigated other banks, including banks in Israel, India and Liechtenstein, for their roles in facilitating US tax fraud by providing non-compliant banking services.

At the same time, other countries, most notably Germany and the United Kingdom, joined in the pressure against foreign banking secrecy. Switzerland and other “tax havens” have been made to sign many tax information exchange (TIE) agreements and have agreed to new standards of financial transparency. The cumulative results of this multi-prong offensive has been the elimination of foreign banking secrecy vis-a-vis governmental tax authorities.

Still, there are US taxpayers who have chosen not to participate in the IRS voluntary disclosure programs and have not brought their foreign assets into tax compliance, notwithstanding the significantly greater risks of discovery. Such taxpayers must confront the challenges of continuing to maintain a non-compliant foreign account, the probability of discovery, and the massive and crippling fines and potential criminal tax fraud consequences that would ensue. While the two voluntary disclosure programs have ended, there still exists a means of bringing a foreign account into tax compliance and avoiding criminal prosecution.

The Continuing U.S. Offensive Against Banking Secrecy

In 2009, U.S. prosecutors achieved a staggering victory against UBS, forcing the largest Swiss bank to settle criminal and civil charges that it aided and abetted tax fraud by assisting Americans to hide funds from U.S. taxation. UBS was also compelled to disclose to the IRS the identities of thousands of Americans with formerly “secret” Swiss accounts. This was a stunning breach of hitherto ironclad Swiss banking secrecy. To date, dozens of Americans with accounts at UBS and other foreign banks have been prosecuted, and 150 grand jury investigations have been opened against taxpayers with foreign accounts. Most of the criminal charges have resulted in guilty pleas, with punishment ranging from probation to jail terms, and significant monetary penalties of half the balance in the foreign account.

Since its victory against UBS, the U.S. has been relentless in its offensive against foreign banking secrecy, pursuing other banks in Switzerland and other countries.

In June, 2011, Credit Suisse revealed that it is the target of a criminal tax investigation by the US Department of Justice. In February and again in June 2011, Credit Suisse bankers were criminally indicted in the US for assisting Americans to hide income from the IRS. The DOJ stated that “the conspiracy dates back to 1953 and involved two generations of US tax evaders including US customers who inherited secret accounts.” The allegations also included a charge that a Credit Suisse banker suggested that non-compliant funds be transferred from Switzerland to a bank in Israel in order to avoid detection by the IRS. Tracing noncompliant funds from Swiss banks to Israeli banks is indicative of the expanding global scrutiny and effectiveness of the investigations. In September 2011, Credit Suisse paid 150 million Euros ($206 million US dollars) to end an investigation by the German Government regarding Credit Suisse bankers assisting Germans in avoiding taxation. In April 2011, Bank Julius Baer likewise settled a German tax fraud investigation with a payment of 50 million Euros.

HSBC is also facing similar allegations, and in 2011 became the subject of a “John Doe” summons in US federal court to reveal the identities of US account holders with undeclared accounts in India. The “John Doe Summons” is an important, effective weapon for prosecutors to uncover once-“secret” banking information from foreign financial institutions. A “John Doe” summons seeks information relevant to a large class of unidentified account holders, rather than a narrow request for accounts of specific, known people suspected of tax fraud. UBS settled civil and criminal tax fraud charges by DOJ, and Swiss banking secrecy ultimately ended, as a result of the John Doe summons served against UBS in 2008. It was once thought that without actual names of account holders and account numbers, prosecutors could not obtain information from foreign banks. The success of the John Doe summons against UBS proved otherwise. Now, a broad class of account holders, not identified specifically other than “Americans with accounts at HSBC”, are vulnerable to discovery and prosecution by the government.

Given the sizeable presence of HSBC and Credit Suisse in the US – – branches in the US, employees in the US, assets in the US and a lucrative banking license in the US – – these banks are clearly within the jurisdiction of US courts. HSBC and Credit Suisse, like UBS before, will likely cooperate and, sooner or later, provide the requested banking data to US authorities.

In addition to targeting large banks like UBS, Credit Suisse and HSBC, the IRS and DOJ are also moving against smaller banks. In September 2011, DOJ revealed that Swiss banks Julius Baer, Wegelin Bank, Basel Kantonalbank and Zuercher Kantonalbank are also the targets of criminal investigations for facilitating tax fraud. Over the border, Liechtensteinische Landesbank is a similar target. DOJ’s criminal tax division is also investigating three Israeli banks, Bank Hapoalim, Bank Leumi and Mizrahi-Tefahot. As noted above, these banks are under particular scrutiny for offering banking services to American clients fleeing from UBS accounts and attempting to keep one step ahead of American authorities as UBS prepared to reveal client identities and banking data. It has been reported that these additional foreign banks will soon be the targets of US grand jury criminal subpoenas and “John Doe” civil summonses, and that the threshold for revealing the banking data will be accounts valued as low as $50,000. This is a much lower threshold than the 2009 agreement with UBS which covered accounts with a value of over 1 million Euros.

Legitimate Reasons for Offshore Accounts

It should be noted that it is not illegal to have a foreign bank account. Americans can legally invest in foreign markets, own foreign real estate, own foreign businesses, settle and fund offshore trusts and foundations, and deposit their assets into foreign bank and brokerage accounts, provided that they disclose their foreign accounts to the U.S. government and pay U.S. tax on foreign income.

In fact, there are many legitimate and compelling reasons to have a foreign financial account. Investment diversification into foreign currencies, foreign equities, funds and financial products is not only common, it may be financially wise. Many people are concerned about the viability or safety of the US financial system and the US dollar and have diversified their wealth outside the US. Business expansion into new markets or new sources of production is routine. Maintaining foreign accounts and entities like foreign corporations, foundations or trusts may be useful for international business and prudent investment planning. Sophisticated people understand the need for foreign options and foreign diversification. Among them is the use of foreign laws to protect hard-earned assets. Many people understand that their retirement plans in the US may provide for their later years, but that a protected nest-egg in a stable foreign country provides a greater level of assurance for wealth preservation. In addition, the litigious nature of the U.S. has compelled many people to protect and preserve their assets in foreign jurisdictions where the likelihood of creditor success is significantly low. Notwithstanding the eradication of banking secrecy vis-a-vis the IRS, confidentiality from one’s private creditors and other financial challengers remains. These are all legitimate reasons to bank offshore, but, as noted, the foreign accounts must be disclosed to the IRS and taxes paid on any gains.

Difficulties in Continuing to Bank Offshore

Notwithstanding the legitimacy of tax-compliant offshore banking, in response to the U.S. offensive, many foreign banks are simply telling Americans to bank elsewhere. American taxpayers wishing to maintain foreign accounts now have to find financial institutions willing to accept their accounts. There are foreign banks who still welcome American clients, but only if the clients sign waivers and provide evidence of IRS compliance, including W-9 Forms. Of course, Americans must locate credible, reliable banks in safe, stable foreign jurisdictions. The ongoing issues are stability and compliance and no longer tax secrecy.

An additional challenge will soon arise for offshore banking in light of the Foreign Account Tax Compliance Act (FATCA), which was signed into law in 2010 as part of the HIRE Act. FATCA imposes additional reporting requirements on US taxpayers with foreign holdings, and also obligates foreign banks to report account information to the IRS. FATCA’s reporting requirements were scheduled to commence in 2013, although some of the disclosure requirements will be phased in over 2014 and 2015. Americans with foreign assets will also be obligated to annually file a new Form 8938, “Statement of Specified Foreign Financial Assets”. This new form is in addition to the “FBAR” form, “Report of Foreign Bank and Financial Accounts” (TD 90-22.1), currently due each year on foreign bank accounts valued over $10,000.

These new requirements impose additional burdens on disclosing foreign accounts and assets. Nevertheless, if the foreign assets are properly reported and are tax-compliant, then there should be no fear of IRS scrutiny, and the benefits of the foreign account – – international diversification, investment planning and asset protection – – are not only obtainable, but the tax compliance imparts an additional layer of confidence and security.

What to Do with a Non-compliant Foreign Account?

What if you still have a foreign account that is not tax-compliant?Option A: Do Nothing
You could do nothing and hope that the IRS does not discover the account. Perhaps your account is at a bank that you believe to be “off the radar” or is in a quieter jurisdiction. Given the changing context of foreign banking and the recent erosion of offshore secrecy, sooner or later the IRS may find you and then it will be too late. Discovery is a distinct possibility given all of the tools at the disposal of the IRS and US law enforcement agencies: Tax Information Exchange (TIE) Agreements, Mutual Legal Assistance Treaties (MLATs), Qualified Intermediary (QI) Agreements with foreign banks, John Doe Summonses, plus the trove of information that the IRS already has in its possession via the two voluntary disclosure programs which resulted in details about banks in 140 countries. Even if your foreign funds are at a bank that has managed to, so far, avoid detection and investigation, the ongoing question will be: how long can this bank avoid the same scrutiny now focused on virtually every other bank in every stable country? Moreover, even if you determine to leave your funds where they are, those funds would essentially be paralyzed. The minute you attempt to access those funds, you could be sending “red flags” that could tip-off law enforcement. For these reasons, the “take your chances” strategy is not recommended.

Option B: Amend Past Tax Returns (“Quiet Disclosure”)
Some US taxpayers with undeclared foreign accounts are hoping to “sneak by” by amending their past tax returns quietly, and paying back taxes on income earned in a foreign account. This is known as a “Quiet Disclosure”.

The IRS has announced that it is aware of taxpayers attempting Quiet Disclosures, and this strategy will not work. The IRS is targeting amended tax returns reporting increases in income, to determine if enforcement action is appropriate. Such amended returns are “red flags”. Even though tax returns are amended and back taxes paid, account holders will still face penalties and criminal charges. In addition to charging and prosecuting people with undeclared foreign income, DOJ has also begun prosecution of taxpayers whose “Quiet Disclosures” were discovered by the IRS.

There are other problems with “Quiet Disclosures”. They only address payment of back taxes and interest, not penalties. Also, they do not address the issue of the taxpayer’s failure to report the foreign account, i.e., filing the “FBAR”, and 1040 “check the box”. If the foreign account was in the name of a foreign trust, then an IRS Form 3520 was probably due also. If the foreign account was in the name of a foreign corporation, then an IRS Form 5471 was probably due. Quiet disclosure does not correct these past non-reporting issues and will not avoid the massive penalties for failing to disclose timely.

Option C: Pre-emptive Disclosure and Negotiation (“Voluntary Disclosure”)
If you currently have an interest in a non-compliant offshore account, you should consider voluntary disclosure of that interest before the IRS discovers it. Even though the 2009 and 2011 voluntary disclosure programs have both ended, the IRS still maintains a voluntary disclosure policy. That policy allows for taxpayers to come forward and disclose their non-compliant foreign assets. This must be done before the IRS already knows about the taxpayer’s foreign assets. Additionally, the taxpayer cannot already be under audit or investigation. And the foreign assets cannot be connected to criminal activity. If these prerequisite requirements are met, a voluntary disclosure offers reduced penalties and a promise of no criminal prosecution. Although fines and penalties may be significant, they pale before the consequences of an IRS criminal prosecution. Such a pre-emptive disclosure is best made by qualified legal counsel, experienced in offshore compliance and IRS negotiations.

If you are an American taxpayer with an offshore account that you thought was secret, you must bring it into compliance. Although the two voluntary disclosure programs have ended, an open IRS voluntary disclosure policy still exists. Given the elimination of offshore banking secrecy discussed above, you should expect that the IRS will soon learn about your offshore account. If the IRS gets your name, it will be too late to take advantage of the voluntary disclosure policy.

In 2009, U.S. prosecutors achieved a staggering victory against UBS, forcing the largest Swiss bank to settle criminal and civil charges that it aided and abetted tax fraud by assisting Americans to hide funds from U.S. taxation. UBS was also compelled to disclose to the IRS the identities of thousands of Americans with formerly “secret” Swiss accounts. This was a stunning breach of hitherto ironclad Swiss banking secrecy. Yet, since then, the IRS has criminally prosecuted fewer than two dozen Americans for hiding offshore accounts to escape taxation.

Contrary to the perception of “calm” since the UBS settlement, recent events make clear that the IRS is still very active in ferreting out undisclosed offshore assets. The IRS is investigating additional banks and other jurisdictions, and prosecuting more Americans with undeclared foreign funds. The IRS’ continuing efforts are buttressed by further erosions of banking secrecy by Tax Information Exchange agreements between the U.S. and former “tax haven” jurisdictions, and by disclosures of offshore bank clients made by disgruntled bank employees. In addition, the new Foreign Account Tax Compliance Act (FATCA) creates new reporting requirements for U.S. taxpayers and foreign financial institutions, which will provide more information to IRS investigators.

However, notwithstanding this continuing offensive against non-compliant offshore banking, the IRS has offered a new opportunity for Americans to bring their foreign accounts into tax compliance via the 2011 Offshore Voluntary Disclosure Initiative.

We’ve known for months that HSBC is the target of a criminal tax fraud investigation by the U.S. Department of Justice (DOJ), for facilitating non-compliant offshore accounts. In the summer of 2010, DOJ sent letters to HSBC foreign account holders, advising them that they are the subjects of criminal investigations relating to unreported accounts in India and Singapore. DOJ has prosecuted a Virginia surgeon and two Miami Beach real estate developers for undeclared foreign accounts with HSBC.

In early February 2011, these real estate developers, father Mauricio Cohen Assor and his son Leon Cohen-Levy, were each sentenced to ten years imprisonment for utilizing undeclared foreign HSBC accounts and foreign entities such as Panama and Bahamas corporations in order to avoid U.S. taxation. Whereas most of the earlier offshore tax fraud prosecutions resulted in plea bargains for more lenient punishment, such as probation and home detention, the Cohens’ ten year sentences resulted from the first court trial of the recent offshore account prosecutions. It should be noted that use of intermediary entities, such as foreign corporations, trusts or foundations, in order to obscure the true beneficial ownership of the underlying foreign bank account, seems to draw the ire of the IRS even more than a foreign account held personally, although both types of non-compliant foreign accounts could give rise to criminal tax fraud charges.

There are also reports that HSBC is implicated in the recent criminal prosecution of Vaibhav Dahake, an Indian-American with undeclared accounts in India and the British Virgin Islands. While the criminal indictment against Mr. Dahake does not mention HSBC by name, it alleges that an “unidentified bank” operated a division called NRI Services which specifically marketed foreign banking services to Americans of Indian decent. According to the allegations in the indictment, the bank advised that accounts be opened in India because of higher interest rates, no U.S. tax forms or social security numbers were required, and the accounts would not be taxed in India. Interestingly, the indictment details transactions with a total value of less than $200,000. This suggests that the government is sending a message that all noncompliant foreign accounts, large and small alike, are vulnerable to investigation and prosecution.

While the Cohen and Dahake prosecutions involve HSBC accounts, other banks are also targets. In December 2010, Deutsche Bank paid $553 million to settle tax fraud charges brought by the U.S. government. The charges related to tax shelters set up from 1996 through 2002 that were ultimately determined by the courts to be shams. Accounting firm KPMG was previously prosecuted for promoting these tax shelters. While sham tax shelters differ from unreported offshore bank accounts, the government’s efforts against Deutsche Bank indicate the government’s growing initiative against banks that facilitate tax fraud.

In addition, there have been reports that some clients of Swiss banks, when faced with the prospect of U.S. prosecution, disclosed to the IRS a portion of their funds at UBS, but moved other undisclosed funds to smaller banks that were supposedly “off the radar”. The recent criminal prosecution of UBS banker Renzo Gadola, accused of advising and assisting Americans to evade taxes, now places those smaller Kantonal (regional) Swiss banks firmly “on the radar”. The allegations are that Mr. Gadola utilized a small bank, Basler Kantonalbank, rather than UBS, in order to avoid detection. We can now add Basler Kantonalbank (and presumably other regional Swiss banks like Zurich Kantonalbank) to the list of banks being investigated. Banks large and small, and accounts of all sizes are vulnerable. Taxpayers should not believe that an account under a certain size is “safe” from discovery, nor is any bank, regardless of its size, “off the radar”.

It should be noted that that the Kantonal banks do not have a U.S. presence. It was the substantial U.S. presence of UBS, and now HSBC, that made such banks vulnerable to U.S. prosecution. With U.S. banking licenses, multiple branches within the U.S., thousands of employees in the U.S., and billions of dollars in assets in the U.S., these banks are clearly within the jurisdiction of a U.S. court and susceptible to an adverse court judgment or order. UBS had to settle the tax fraud charges against it because the alternatives — seizure of its U.S. assets and revocation of its lucrative U.S. banking license – – would have been catastrophic.

While the smaller Kantonal banks do not have a U.S. presence, they are still subject to Swiss law, which now requires cooperation with the IRS. Following generations of Swiss banking secrecy, in 2010 Switzerland’s Parliament changed long standing Swiss banking secrecy laws to allow for cooperation and exchange of information with the IRS in both criminal and civil tax investigations. In 2009, Switzerland and the U.S. signed a new Tax Information Exchange Agreement (TIA), which further eroded Swiss banking secrecy. The new agreement allows the U.S. greater access to Swiss banking records of American taxpayers, including records at the smaller Kantonal banks.

Whistle Blowers, Snitches and Thieves

Bank employees handing over supposed “secret” banking data is not new. Back in 1999, John Mathewson, the former owner of Guardian Bank and Trust, a defunct Cayman Islands Bank, was charged in the U.S. with money laundering. When Mr. Mathewson was arrested, he gave Federal investigators bank records that contained information about American depositors at the bank who had evaded U.S. tax obligations. Mathewson gave up the banking data in return for leniency in his criminal sentencing.

In 2008, a renegade employee of LGT Bank in Liechtenstein stole data about client accounts and sold the data to the German intelligence service in return for millions of Euros. With that data, the German government prosecuted many prominent Germans for tax fraud. The German government also shared the data with other governments around the world. In 2009, an employee of HSBC provided bank account data to the French government. In 2010, Germany again purchased banking data, stolen by an employee of a Swiss bank. The DOJ was able to successfully prosecute UBS, and then UBS clients, because of information that had been disclosed by UBS banker Bradley Birkenfeld to the U.S. government.

Further Erosion of Banking Secrecy: WikiLeaks and Bank Julius Baer

The next bank appears to be Julius Baer, and this disclosure will apparently be made via WikiLeaks. The banking data to be revealed comes, like the Guardian, LGT, UBS and HSBC cases mentioned above, from internal bank sources; specifically, a disgruntled former employee of Julius Baer.

Julius Baer is already “on the radar” because many Americans accepted into the IRS Voluntary Disclosure Program have disclosed their Julius Baer accounts. For Americans who did not disclose their Julius Baer accounts, immediate disclosure is strongly advised. Once the IRS gets the name of an account holder from WikiLeaks or any other source (audit, whistleblower, investigation or otherwise) a voluntary disclosure is too late and criminal prosecution is likely.

Targets Beyond Switzerland

There are reports that IRS and DOJ investigators are also focusing on banks in Asia and the Middle East. Following the erosion of Swiss banking secrecy, large amounts of funds were reported to have been moved from Switzerland to Singapore. However, Singapore has taken steps to be removed from the OECD (Organization for Economic Co-Operation and Development) “grey list” of foreign tax havens and has discussed entering into a double-taxation treaty with the U.S. and other countries. In order to preserve its status as a major financial hub, Singapore has taken steps toward greater financial transparency. In addition, as the HSBC investigation discussed above illustrates, Singapore is very much under the watch of the IRS.

Following its success against UBS, the IRS has expanded beyond undeclared Swiss accounts to undeclared funds in other foreign jurisdictions. The IRS has opened or will soon open field offices in Panama, Australia and China. Tax Information Exchange Agreements have been signed by all the former “tax havens”, including Liechtenstein and Monaco. While the IRS is intensifying its presence and its available tools around the world, it appears that it is concentrating on India and Israel more particularly.

New IRS Target: India

As noted above, HSBC is reported to have specifically targeted Indian-American clients and offered offshore banking services in India and Singapore. The HSBC-India connection represents a particular tangent of offshore banking that will surely warrant scrutiny. Whereas UBS advised American clients that their accounts may be subject to exposure to the IRS, and therefore suggested pre-emptive disclosure, Americans with accounts at HSBC in India received letters from DOJ in 2010, making it clear that DOJ already had their names. In such a case, pre-emptive disclosure is impossible; the IRS will reject a voluntary disclosure if the taxpayer is already under investigation or if the IRS already has the taxpayer’s name (regardless of the source, e.g., audit, whistle blower, etc.).

On this point, it appears that the stolen LGT bank data purchased by the German government (discussed above) was also shared with the government of India. At home, the Indian authorities have launched prosecutions of its citizens who had undeclared accounts outside of India. In 2010, India signed a tax information exchange treaty with Switzerland, and India is in the process of negotiating tax treaties with 65 countries. While there is currently no tax treaty between India and Liechtenstein, Liechtenstein has shown its new transparency by promulgating multiple tax treaties with other countries, including the U.S., and a future treaty with India is likely. But even in the absence of such a treaty, India already has names, thanks to the LGT affair. The LGT information is almost certainly in the possession of the IRS as well.

Another IRS Target: Israel

Some Americans feel mistakenly comfortable not disclosing their Israeli bank accounts to the IRS because of Israel’s close ties with the U.S. They mistakenly believe the IRS is reluctant to investigate Israeli banks. However, owners of accounts in Israel may soon feel the brunt of the next wave of IRS crackdown into offshore banking.

Israel is in a unique situation vis-a-vis the IRS because of ties between Israel and Jews around the world, including Jews who have inherited “Holocaust accounts”. One example of a “Holocaust account” is an account established in Switzerland by European Jews prior to the Holocaust, in an attempt to safeguard their assets from the rise of Nazi Germany. Another example is an account established after World War II by a Holocaust survivor in order to receive German reparation payments. In either case, tax avoidance was not the motivation behind the establishment of the accounts. (The same can be said of Greeks fleeing persecution in Turkey, who put their funds in Switzerland for reasons of safety and stability, or Egyptian Jews fleeing the military coup and dictatorship of Gamal Nasser, or various other refugees who put their money is Swiss banks to preserve and protect their assets in the face of persecution and upheaval.) Now, many decades later, their descendants who have inherited these accounts are in a position of unintended tax non-compliance because they were not aware of their obligation to annually report these accounts to the Treasury Department on Form TD 90-22.1, the Report of Foreign Bank and Financial Accounts, or “FBAR”, even if no tax was due.

Whereas Swiss bank secrecy laws presented a formidable challenge to the IRS prior to the UBS case, pursuing undisclosed accounts in Israel will not require nearly as much effort. The tax treaty between the U.S. and Israel enables the two countries to “exchange such information as is pertinent to . . . fraud or fiscal evasion in relation to the taxes which are the subject of this Convention.” Cooperation between the U.S. and Israel is routine in many matters, tax and otherwise. According to the Israeli Ministry of Justice, “the [Israeli Government] has cooperated with requests from U.S. law enforcement in matters of financial crime . . . .” Although this statement refers to Israel’s fight against money laundering, it is not a stretch to conclude that the Ministry would cooperate with requests from the IRS in matters specifically pertaining to undisclosed bank accounts.

In addition, the U.S. and Israel currently grant legal assistance to each other in criminal matters via a Mutual Legal Assistance Treaty (MLAT). The MLAT states that the U.S. and Israel “express their understanding that this treaty applies to . . . criminal tax offenses . . . .” It is particularly noteworthy from an offshore banking perspective that for “serious [fiscal] offenses involving willful, fraudulent conduct,” the treaty even provides for the exchange of bank records.

It is not our conclusion that the IRS is specifically targeting “Holocaust accounts”. Indeed, whereas the Voluntary Disclosure penalty for offshore accounts was 20%, a specially reduced 5% penalty applied to Holocaust accounts. We believe that the presence of undeclared assets in Israel (whatever their source, including the cash-heavy jewelry trade) presents a specific target to the IRS. Along these lines, in 2010, Israel’s Bank Leumi took the extraordinary step of sending letters to its U.S. customers, strongly advising them to disclose their accounts to the IRS.

A Glimmer of Relief: A New Voluntary Disclosure Program

In February 2011, the IRS announced the Offshore Voluntary Disclosure Initiative (OVDI), which closely mirrors the 2009 Offshore Voluntary Disclosure Program (OVDP), with a few refinements. The new penalties are 25%, greater than the 20% penalty under the prior OVDP, yet less than the 50% penalty that the IRS has been imposing in recent criminal tax fraud prosecutions.

The new OVDI presents an opportunity for Americans with foreign accounts who did not come forward under the former OVDP, but still want to avoid criminal prosecution and bring their foreign accounts into compliance. As we’ve noted repeatedly, the IRS continues to target foreign accounts. We strongly advise taxpayers to bring non compliant foreign accounts into tax compliance, in order to avoid discovery by the IRS, higher penalties and criminal prosecution. In this new era of international transparency, decreased banking secrecy and stronger enforcement efforts, offshore banking compliance is very highly recommended.

In the past, Americans with bank accounts in foreign countries were able to rely on secrecy as a protection against the IRS. Banking secrecy was codified as statutory law (and in some cases, written into the constitution) of certain countries. Other countries observed long traditions and cultures of financial secrecy. Although Switzerland signed a Mutual Legal Assistance Treaty (MLAT) with the US back in the 1990’s, that treaty allowed for secrecy to be breached and information shared only for criminal investigations, not the mere failure to report income in a foreign bank account. Thus, Americans with accounts in Switzerland were able to rely on Swiss banking secrecy, as long as they were not connected with criminal activities.

No longer. Recently, offshore banking secrecy has been significantly eroded. Now, in all countries, failure to report a foreign account or income in that account constitutes criminal activity and will give rise to exchange of banking information with the IRS.

Recent Erosion of Offshore Banking Secrecy

Consider the following, all within the past few months:

The IRS has sued UBS, criminally and civilly, claiming that UBS conspired and even encouraged Americans to hide income in secret UBS accounts. In February, 2009, UBS settled the criminal charges, paid a large fine and handed the IRS the names of hundreds of Americans with UBS accounts. The IRS is now investigating and prosecuting these account holders. In the civil lawsuit, the US has subpoenaed the names of some 52,000 Americans with undeclared UBS accounts. Given UBS’ significant presence and immense volume of assets in the US, we expect that eventually, UBS will comply with the subpoena.

The IRS is also investigating Credit Suisse and HSBC. The IRS has stated that many other offshore banks are being targeted for investigation as well. One IRS tactic is to issue “John Doe” summonses, which seek information on an entire class of unknown account holders, rather than an individual taxpayer already known to have a foreign bank account. Courts have already proven their willingness to grant such “John Doe” summonses.

The OECD (Organization for Economic Co-Operation and Development), a multi-governmental organization based in Europe, is pursuing its own campaign against “tax havens”. In March, 2009, virtually all of the formerly “secret” tax haven jurisdictions, including Switzerland, Liechtenstein and Monaco, agreed to the exchange of banking information with foreign governments, including the US. This ends decades and in some cases centuries of banking secrecy.

Domestically, President Obama and Senators Levin and Baucus have each introduced proposed legislation targeting foreign accounts and Americans who own them. President Obama’s legislation seeks to increase the IRS budget and manpower to pursue undeclared money offshore, including hiring 800 IRS special agents to investigate foreign accounts.

Government officials of Caribbean and Central American jurisdictions have advised us that the Obama administration has already indicated to them that Tax Information Exchange Agreements (TIEAs) are on the way and are non-negotiable. Under these TIEAs, the US Treasury Department can request assistance directly from foreign banks in cases of IRS civil audits.

What Should You Do if You Have an Offshore Account?

In light of the above challenges to offshore banking, Americans with undisclosed foreign accounts, including accounts held in the name of companies, trusts or nominees, have reason to be seriously concerned.

There are two potential issues with undisclosed offshore bank accounts: First, not reporting the existence of those accounts to the government (on disclosure forms such as US Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Account (the “FBAR”), and “checking the box” on the 1040 annual tax return), which can result in significant fines and penalties. The second issue is not paying tax on income earned in a foreign bank account. Failure to pay taxes carries significant civil and criminal consequences. Usually, an undeclared foreign account will involve both issues; not reporting the existence of the account and not paying taxes on income in that account, resulting in a host of attendant civil and criminal fines and penalties, even jail.

If You Have an Undeclared Foreign Bank Account, What Should You Do?

Option A: Do Nothing

You could do nothing and hope that the IRS does not discover the account. You would be relying on past banking secrecy as a means of providing some degree of protection going forward. Perhaps your account is not at a large bank like UBS, or is in a quieter jurisdiction, and is “off the radar”. Given the changing context of foreign banking and the recent erosion of offshore secrecy, sooner or later the IRS may find you and then it will be too late. As discussed above, this strategy is not recommended.

Option B: Amend Past Tax Returns (“Quiet Disclosure”)

Some US taxpayers with undeclared foreign accounts are hoping to “sneak by” by amending their past tax returns quietly, and paying back taxes on income earned in a foreign account. This is known as a “Quiet Disclosure”.

On May 7, 2009, the IRS announced that Quiet Disclosures will not work. The IRS is targeting amended tax returns reporting increases in income, to determine if enforcement action is appropriate. Even though tax returns are amended and back taxes paid, account holders will still face penalties and criminal charges.

There are other problems with “Quiet Disclosures”. They only address payment of back taxes and interest, not penalties. Also, they do not address the issue of the taxpayer’s failure to report the foreign account, i.e., filing the “FBAR”, and 1040 “check the box”. If the foreign account was in the name of a foreign trust, then an IRS Form 3520 was probably due also. If the foreign account was in the name of a foreign corporation, then an IRS Form 5471 was probably due. Quiet disclosure does not correct these past non-reporting issues.

We’ve continually counseled our clients that “Quiet Disclosures” may not suffice. Now the IRS has confirmed our advice.

If you currently have an interest in a non-compliant offshore account, you should consider voluntary disclosure of that interest before the IRS discovers it. The IRS is offering a sort of amnesty to taxpayers who voluntarily come forward before they are discovered. The IRS’ Voluntary Disclosure Program offers reduced penalties and a promise of no criminal prosecution. Such a pre-emptive disclosure is best made by qualified legal counsel, experienced in offshore compliance and IRS negotiations. We can approach the IRS on your behalf, demonstrate proper current compliance and negotiate to avoid criminal prosecution and reduce fines and penalties for past non-compliance. Although fines and penalties may be significant, they pale before the consequences of an IRS criminal prosecution. We have a very successful track record with the IRS.

If you are an American taxpayer with an offshore account that you thought was secret, you have very little time to bring it into compliance. Given the elimination of offshore banking secrecy discussed above, you should expect that the IRS will soon learn about your offshore account. UBS has already revealed the identities of some US account holders, and we can expect that UBS, Credit Suisse, HSBC and other banks will provide a complete list of US account holders in the near future. If the IRS gets your name, it will be too late to take advantage of the Voluntary Disclosure Program.

Option D: Convert to a Tax-Compliant Structure

We have long counseled proper tax disclosure of foreign accounts and the use of tax-compliant strategies to minimize US taxation on foreign assets. We also advise clients on the legitimization of non-compliant offshore assets. We counsel clients with regard to transforming a non-compliant offshore account into one that complies with current US law. Although we cannot erase a non-compliant past, we can ensure full compliance going forward. Converting a non-compliant foreign account into a compliant structure is often done in tandem with a Voluntary Disclosure. In other words, make amends for past non-compliance, and ensure ongoing future compliance.

Conclusion

Failing to remedy a non-compliant offshore account puts you at serious risk of harsh penalties in the event of discovery, including IRS criminal prosecution. As recent events have proven, discovery is very likely. The window of opportunity is closing fast. See us before the IRS sees you.

Asset protection is defined as the safeguarding of wealth and assets from attack by future, unsecured creditors. The assets that we have protected include liquid assets, securities, real estate, business interests, professional practices, works of art, intellectual property, cars, boats, jewelry and virtually anything of value. We protect these assets from threats such as aggressive litigants and predatory creditors, and preserve the assets for the benefit of our clients and their families.

We carefully safeguard the privacy of our clients and the confidentiality of their assets. Rather than basing asset protection strategies on the supposed “banking secrecy”, we use the law – – both U.S. and foreign – – to create secure, impenetrable barriers around those assets. As a result, our asset protection strategies have withstood the test of time as well as governmental and judicial scrutiny.

Internationally, we have developed strategies utilizing asset protection trusts, corporate entities, limited partnerships and more esoteric vehicles such as foreign annuities and private placement insurance, which have successfully protected clients’ assets in extremely sensitive situations.

In order to ensure the safety of our clients’ offshore assets, we have developed long standing relationships with well credentialed international banking institutions, attorneys, trustees and government officials at the highest levels in various offshore jurisdictions.

by Asher Rubinstein, Esq. and Julie Otton[1. Asher Rubinstein is a partner at Rubinstein & Rubinstein in New York City. His legal practice is in the areas of asset protection, wealth preservation, tax compliance and tax controversy. Julie Otton is a law student at New York Law School. They may both be reached at (212) 888-6600 and via www.assetlawyer.com.]

As part of the expanding global scrutiny of offshore bank accounts, the IRS and the criminal tax division of the U.S. Department of Justice (DOJ) have now focused attention on three of Israel’s biggest banks: Bank Leumi Le-Israel, Bank Hapoalim and Mizrahi-Tefahot Bank, to see if they helped U.S. citizens to evade taxes. We believe that additional Israeli banks, not publicly named, are also under investigation.

Investigation of Israeli banks follows the erosion of Swiss banking secrecy and U.S. legal action against multiple foreign banks including UBS, Credit Suisse, Wegelin and HSBC. The IRS is now scrutinizing banks outside of Switzerland, including Liechtenstein, India and other countries. In the case of Israeli banks, American authorities are concerned with the flow of non-complaint money from Switzerland to Israel in recent years. As Swiss banking secrecy faded over the past few years, and the U.S. extracted once-“secret” Swiss account details, many taxpayers transferred assets from Switzerland to Israel to avoid detection by the I.R.S. Now, the IRS has caught up with them. The IRS and the DOJ have recently been targeting American taxpayers with accounts in Israel. In addition, there are reports that the IRS is auditing American expats living in Israel.

Many Americans maintain bank accounts in Israel for various reasons: business ties, costs associated with owning real estate in Israel, accounts to assist family members, etc. It is completely legal to have an account in Israel, provided that (1) the account is disclosed to the IRS on (a) IRS Form 1040, Schedule B, (b) the “FBAR”, Report of Foreign Bank and Financial Accounts, Form TD 90-22.1, (c) new IRS Form 8938, Statement of Specified Foreign Financial Assets, and (2) income earned in the account, including interest, dividends and capital gains, is reported to the IRS and taxes paid on this income. (Taxes paid in Israel on such income may offset U.S. taxes.) So long as these conditions are met, the account is tax compliant. If the account is not tax compliant, a U.S. taxpayer who owns or has beneficial interest in an Israeli account can be prosecuted for civil and criminal tax fraud.

Whereas until recently, Swiss bank secrecy laws presented a formidable challenge to the IRS, pursuing undisclosed accounts in Israel will not require nearly as much effort. The tax treaty between the U.S. and Israel enables both countries to “exchange such information as is pertinent to . . . fraud or fiscal evasion in relation to the taxes which are the subject of this Convention.” Cooperation between the U.S. and Israel is routine in many matters, tax and otherwise. In addition, the U.S. and Israel currently grant legal assistance to each other in criminal matters via a Mutual Legal Assistance Treaty (MLAT). The MLAT states that the U.S. and Israel “express their understanding that this treaty applies to . . . criminal tax offenses . . . .” It is noteworthy that the treaty provides for the exchange of bank records.

In addition to the criminal tax investigations and prosecutions, a recent U.S. law called FATCA (the Foreign Account Tax Compliance Act), passed by Congress in 2010 and signed by President Obama, will come into effect in 2013 and mandate greater disclosure of Israeli account information to the IRS. FATCA requires foreign banks to report to the IRS all names and account information of U.S. beneficial owners of foreign accounts. If a foreign bank fails to make a FATCA disclosure to the IRS, the bank will incur a 30% withholding penalty on its U.S. sourced income. Because banks like Leumi have a substantial U.S. presence and U.S. investments, Leumi will begin FATCA reporting to the IRS. It has recently been reported that all Israeli banks, even those without a U.S. presence, intend to become FATCA-compliant because they do not want to be branded as non-compliant and subject to the 30% withholding.

In response to the IRS/DOJ criminal tax investigations, Israeli banks are not waiting until FATCA’s 2013 start date to demonstrate their compliance. In March 2012, Bank Leumi sent letters to its U.S. customers requesting IRS Form W-9, the Request for Taxpayer Identification Number and Certification. Customers who fail to declare compliance with U.S. tax reporting requirements may have their Leumi accounts frozen. Further, an Israeli bank can no longer merely rely on an Israeli passport if the bank has reason to believe that the client is also a U.S. citizen or resident. Bank Leumi notified customers that without certification of U.S. tax compliance, the account balance will be transferred in the name of the account holder outside of Leumi Group or via a bankers draft payable only to the account holder. Bank Hapoalim made a similar customer request. The fact that the funds will only be transferred to the named account holder will prevent the account holder from transferring the funds to another “hidden” or “secret” account.

Further, the Association of Banks in Israel has urged Israel’s central bank, Bank of Israel, to ask the Israeli government to reach an agreement with the U.S. in order to minimize the procedural disruptions that FATCA reporting will cause each bank. Rather than each bank reporting directly to the IRS, Israeli banks would report account information to their government, which would then provide that information to the U.S. government. Five European countries have already signed similar agreements with the U.S. on FATCA compliance, including France, Britain, Spain, Italy and Germany, in order to avoid each individual bank reporting directly to the IRS.

Against this background of tax investigation, criminal prosecution and tougher reporting standards, the IRS re-opened its Offshore Voluntary Disclosure Initiative (OVDI) in January 2012 in order to encourage owners of non-compliant foreign accounts to come forward and clean up the accounts. The OVDI provides a means to declare the foreign account to the IRS, bring the account into tax compliance and avoid criminal prosecution. The applicant will have to pay back taxes (and interest) on the income earned in the foreign account for the last eight years, pay a 20% “accuracy” penalty on that tax, and then pay a one-time penalty on the highest value of the foreign assets, as much as 27.5%. Some taxpayers may be eligible for a lower penalty of either 12.5% or 5%, depending on the specific facts of the case. This lower penalty might apply to some Israeli accounts such as “Holocaust accounts,” accounts inherited by heirs of Holocaust survivors where tax avoidance was not the motivation behind establishing the account.

However, some people with undisclosed Israeli accounts are not prepared to pay the taxes and penalties. They have few options. Continuing to rely on banking secrecy is not prudent given the many recent breaches of banking secrecy, including even once-sacrosanct Swiss banking secrecy. FATCA will make it impossible to maintain an account “under the radar,” and Israeli banks are demanding evidence of U.S. tax compliance now, even before FATCA takes effect.

Some account holders have closed their accounts and moved the funds elsewhere. In fact, it has been reported that Americans have withdrawn more than one billion dollars of assets from Israeli banks over the past few months. However, simply withdrawing money or closing an account does not remedy the problem. The IRS focuses on non-compliant accounts and unreported foreign income even in prior years. In the UBS matter, the IRS looked as far back as 2000. As a practical matter, closing a non-compliant Israeli account and moving the funds to another bank will lead to source of funds questions and “know your client” due diligence, as well as the current reality that very few, if any, reliable banks will take funds with “no questions asked” and no tax reporting. Moreover, there is almost always a money trail to the new bank which the IRS can discover. Just as the IRS followed money from Switzerland to Israel, it will follow it to other jurisdictions. Most other jurisdictions are also vulnerable to IRS investigations, DOJ legal challenges and the reach of FATCA.

Some Israelis are considering revoking their U.S. citizenship in order to avoid the burden of U.S. taxes and reporting. However, without proper advanced tax planning, expatriation can result in an IRS “exit tax”. Nevertheless, expatriation requests are on the rise. The most recent publicized example is Eduardo Saverin, co-founder of Facebook, who gave up his U.S. citizenship on the eve of the recent Facebook initial public offering and avoided millions of dollars of U.S. tax.

American taxpayers who decide to renounce their U.S citizenship may benefit from a new Israeli incentive offering tax benefits to new immigrants and “senior returning residents,” i.e., Israelis who have lived outside of Israel for ten years. Before expatriating, consultation with a U.S. tax lawyer is recommended in order to address, and minimize, the U.S. “exit tax”.

Clearly, the world of international banking and taxation has changed considerably over the past few years, and there should be no expectation of hiding foreign assets from the IRS. The IRS and DOJ have displayed relentlessness in pursing once-secret foreign accounts and prosecuting the U.S. owners of the accounts for tax fraud. After achieving notable success against Swiss banking secrecy, the IRS appears to be focusing on Israeli accounts with similar scrutiny.

This week, DOJ announced indictments against three Israeli-American tax preparers for helping their clients hide monies from the IRS, including moving money to Israeli banks, and using foreign corporations to hide income.

The DOJ press release, “Three Tax Return Preparers Charged with Helping Clients Evade Taxes by Hiding Millions in Secret Accounts at Two Israeli Banks”, can be found here.

According to the CNBC report, “the indictment revealed the existence of a grand jury that is almost surely going after much bigger fish.” Further, “the new case is just the beginning of a potential series of indictments, which may snare some of the wealthy American clients who have hidden money in Israel, many for generations. That’s likely to be politically controversial . . . .”

In light of the IRS and DOJ enforcement efforts against offshore accounts that are not tax compliant, owners of such accounts should meet with qualified tax attorneys to discuss their situation and their available options. Please contact us for a confidential and privileged discussion about your situation.

To borrow a line from Mark Twain, recent pronouncements about the death of offshore asset protection (e.g. UBS, theft of Liechtenstein bank data) are highly exaggerated. As the following U.S. federal court decision (1) proves, offshore asset protection, when planned by professionals, is alive and well and very effective.

Background

In the 1970’s and early 1980’s, businessman Raymond Grant utilized domestic limited partnerships to take advantage of certain tax credits and deductions which at that time were valid and legal. Then, in 1983 and 1984, Raymond Grant established two irrevocable offshore trusts, one in Bermuda and one in Jersey, both funded with approximately $2.1 million.

In the late 1980’s, the tax law changed, the IRS disallowed the previous tax credits and deductions and in the early 1990’s assessed millions of dollars in back taxes and penalties against Mr. and Mrs. Grant. The Grants challenged the tax assessments and lost. In 1994 they entered into an installment agreement with the IRS whereby the IRS agreed to accept $3,000 per month. The Grants adhered to the installment agreement and paid regularly. In 1999, the IRS agent in charge died and a new IRS agent took over the Grants’ file. The new IRS agent did not like the deal and unilaterally terminated the installment agreement that had been in place for five years, even though the Grants were current on their obligation and had been paying timely and properly.

The IRS Sues

In 2000, the government filed a federal action against the Grants in the Southern District of Florida, charging them with failure to pay federal income taxes, plus interest and penalties. Initially the Grants defaulted, but when the IRS went after the assets in the foreign trusts, the Grants appeared in court. In 2003, the IRS won a judgment against the Grants for over $36 million. In the interim Mr. Grant died. The IRS levied on Mrs. Grant’s Social Security benefits and tax refunds, but found no other U.S. assets.

The Repatriation Order

In 2005, the IRS targeted the offshore trust assets and sought a repatriation order from the federal court. U.S. Magistrate Klein found that Arline Grant held the power to fire and replace trustees, and the power to effect distributions from the trusts to herself. Therefore, Magistrate Klein issued a repatriation order, requiring Arline to either repatriate the assets or fire the foreign trustees and appoint a U.S. resident trustee to administer the trusts, thus bringing the trust assets within U.S. jurisdiction, and available to creditors.

Arline Grant complied with the repatriation order and wrote to both trustees, requesting distribution of the trust assets to her and advising that she was dismissing the foreign trustees and appointing a U.S. resident trustee to administer the trusts.

The trustees rejected Arline’s instructions, claiming that their relinquishment of the trust assets to her would be a breach of the trustees’ obligation to future trust beneficiaries (i.e. the Grants’ children), and that her removal of the current trustees would not be a valid exercise of her powers under the trusts. The trust assets thus remained offshore out of U.S. jurisdiction.

No Contempt

By 2008 the trust assets still had not been repatriated. The IRS urged the Court to hold Arline Grant in contempt for failing comply with the 2005 repatriation order. U.S. District Judge Jordan refused to hold Mrs. Grant in contempt for the trustees’ refusal to repatriate the trust assets, stating that “…this failure is not for lack of effort [by Mrs. Grant]”. Judge Jordan held that because Arline had repeatedly written to the trustees requesting distributions and dismissing the trustees, she had sufficiently established that she was not able to repatriate the assets. The Court stated that when compliance with a court order is impossible, the court cannot hold the respondent in contempt. Arline Grant is free and the trust assets are intact.

Result After Grant

In theory, Magistrate Klein’s order to repatriate should have had a more favorable result for the IRS. After all, according to the trust deeds, Arline did have the power to fire the trustees, and the power to order distributions. The fact that the trustees refused to make distributions and did not allow themselves to be fired was counter to the terms of the trust deeds. But the case centered on contempt. The court did not (and, indeed, could not) concern itself with whether the trustees’ responses were valid. The issue at hand was whether Arline complied with the court’s order to repatriate; she did – – she wrote to the trustees requesting a distribution and dismissing them.

The ultimate issue in this case (as in all other offshore trust contempt cases) was whether the defendant had actual control over the offshore trust assets. Although the trust deeds did, in fact, give Arline power over the trusts – – the power to remove trustees, and the power to require distribution of assets – – those powers proved to be ineffective when the trustees refused to follow Arline’s instructions.

Thus, it was, in fact, impossible for Arline to repatriate the funds, notwithstanding her attempts to remove the trustees and order that the funds be brought back to the U.S. Arline had a paper power over the trusts and their assets, but not an actual power, and the gap between the two rendered it impossible, as a practical matter, to comply with the Court’s order to repatriate. Because of that impossibility, Arline was not in contempt of the repatriation order. The Grant case is a clear pro-debtor decision holding that a contempt order will not be issued where compliance with a repatriation order is impossible.

The lesson for offshore asset protection planners is to prevent a situation where the US client may be found to control the trust. The Grant trusts should never have bestowed powers on Arlene. This would have avoided the Magistrate’s repatriation order in the first place. In the Grant case, the Magistrate correctly held that Arline had power over the trust assets. It was only because of the trustees’ violation of the terms of the trusts that Arlene avoided contempt. A good offshore practitioner should never allow the client to be put in this position. Proper offshore asset protection planning requires the U.S. client to part with all legal control over trust assets. In other words, render repatriation impossible because of lack of legal power, not because of a trustee’s refusal to follow proper instructions. Although the client must part with legal control, the trust assets will still be protected and guarded by licensed, bonded, qualified and reputable trustees who will, at all times, be sympathetic to the client’s real interests.

In the end, Arlene Grant is free, with her money safe in the offshore trusts. The result after Grant confirms what we have long counseled — that offshore asset protection, when done properly and lawfully, is completely legal and 100% effective.